09 Jan How Does a Lender Calculate the Amount for an Impound Account?
This is a question that comes up quite a bit when buyers are purchasing a home. In a separate blog post, we discussed what the Escrow Impound Account is and why it may be beneficial (or required) for a buyer. But we did not discuss how the lender actually calculates the amount for the Impound Account. Let’s take a closer look.
When a buyer is at the stage of their transaction that they are signing loan documents, they are presented with an estimated settlement statement from their escrow holder. On this statement, you will see the initial amount that the lender will collect to set-up the Escrow Impound Account. To buyers, it can often seem like they are paying for months of taxes before they ever take possession of the home.
But remember: you want to think of the Impound Account like a savings account where the funds are used to pay for property taxes and insurance. The lender will require the buyer to pay a monthly amount equal to 1/12th of the amount of the annual property taxes and yearly insurance premiums. To calculate the annual property taxes, the lender multiplies the purchase price of the home by 1.25%. The annual insurance premium is a fixed amount that is determined by the buyer’s insurance agent and given to the lender as a condition of the loan.
Allocation of Funds
In the State of California, property tax bills are issued twice per year. The tax bills are mailed out in October, and the first half of taxes (covering July 1-December 31) are due November 1st. The second half of the taxes (covering January 1-June 30) are due February 1st.
For insurance, the lender will usually require that one full year of insurance be paid in advance through escrow when the account is set-up. They will also collect an additional 2 to 3 months upfront for the Impound Account to account for the next premium that is due one year from the close of escrow.
Most lenders will require an amount equal to two months of reserves to remain in the Impound Account at all times for both annual property taxes and insurance. They calculate this by how many monthly mortgage payments the buyer will have made at the time the bill comes due to determine how much they will collect upfront.
Let’s look at a few examples:
Escrow Closes August 20th
In this example, the buyer’s first payment to the lender will be due on October 1st. The payment of taxes will cover taxes from July 1st through December 31st. To make sure they have enough funds in the Impound Account, they will collect at least eight months of taxes upfront from the buyer through the Escrow Impound Account. While it may seem like the buyer is paying for taxes when they are not the owner of the property, keep in mind that the buyer will receive a credit for taxes from July 1st to August 20th through the escrow in this example.
Escrow Closes February 15th
Here, the buyer’s first payment will be due on April 1st. The lender will make the first payment to the Tax Collector in this instance for the property taxes covering November 1-December 10. This payment will cover the taxes from July 1-December 31, the second half of the year. The lender will have received at least six monthly mortgage payments (including the impound amounts) from the buyer, meaning they would only need to collect 2-3 months upfront from the buyer in the Escrow Impound Account.
If you have additional questions, your lender will be a great resource. And, of course, we are here to help with all of your escrow needs, so please reach out if we can be of assistance.